Emerging market bond exchange traded funds have been a popular source of income in a low yield environment, but with U.S. interest rates rising, these assets have experienced heavy losses. More could be in store if Treasury yields rise further.
The iShares Emerging Markets USD Bond ETF (NYSEArca: EMB) has declined 8.7% over the past three months. The fund has experienced $1.0 billion in outflows since the end of April, according to IndexUniverse data.
Fixed-income assets have weakened with rising interest rates – bond prices have an inverse relationship with yields. The benchmark 10-year Treasury yield rose about 100 basis points since May on speculation that the Fed would begin tapering its quantitative easing program later this year. [Emerging Market Bond ETFs: Use Caution as Rates Rise]
Moreover, the emerging bond market is not nearly as large as the developed markets.Consequently, hot money that moved out during the Fed scare has made a significant impact.
“Interest-rate changes in the U.S. affect overseas investments because the world-bond markets are priced in relation to the U.S. market,” according to Morningstar analyst Timothy Strauts. “If interest rates rise in the U.S., emerging markets become less attractive because of their higher risk versus Treasury bonds.”
Emerging market bond ETF investors should also be aware of duration risk.
“If interest rates rise in the future, the ETF’s above-average duration likely will cause negative fund returns,” Strauts added.